Feedback from users of our website has recommended that we provide links to other relevant financial media commentary.  You may have noticed that we have linked to relevant commentary from sources like Fundadvice.com, Vanguard commentary, Dimensional Fund Advisors commentary, articles from the Australian newspaper and the Australian Financial Review to name a few.

Today I have read a blog Pride, predictions and a falling dollar written by Robin Bowerman, Principal and Head of Retail at Vanguard.  It highlights the impacts of the recent fall in the value of the Australian dollar in terms of foreign currencies. i.e. the exchange rate.

As with all movements in financial markets there are winners and losers.  The losers at the moment are those individuals and businesses who are importing goods or who are planning on travelling overseas either temporarily or permanently, assuming you do not have other currency to support this travel.

The winners are businesses who are exporting goods (based on variable price contracts) and investors who are investing in un-hedged international investments.

Let's first have a look at the impact of currency movements on investors who invest in international investments.

Back in April 2001, the Australian dollar was being exchanged for 48 US cents.  I was well aware of this as I had just re-located to Indonesia and was being paid in US dollars.  I was pretty happy with the exchange rate as every US dollar I saved resulted in 2 Australian dollars reaching my accounts back in Australia.  When I left Indonesia in December 2003, the exchange rate had risen to 1 Australian dollar buying 73 US cents.  One US dollar of saving would result in $1.36 reaching my Australian accounts.  The exchange rate eventually rose to 97 cents in mid July.  This equates to a 102% rise since April 2001.

If you had hedged your international investments in Australian dollars over the past 7 years you would be well ahead of those who had left their international investments un-hedged.  Let's use a simple mathematical example to show why this is the case.

Say you had invested $1,000 Australian dollars into a US dollar investment back in April 2003, you would have been able to buy 480 US$1 dollar units.  Let's assume that these units rose to a value of US$2 by mid July 2008, you would now have an investment of US$960.  At an exchange rate of 97 US cents to the Australian dollar, if you had redeemed this investment you would have received back $931.20 in Australian dollars.  Your investment had actually fallen in Australian dollar terms by $68.20.  An alternative would have been to hedge this investment against movements in the exchange rate.   Basically, hedging takes out the impact of currency movements and transaltes returns on the underlying investments back into the home currency.  If you had invested the $1,000 into a US investment hedged back to the Australian dollar, you would have received $2,000 back in your hand (assuming that it cost nothing to hedge).  I know which option I would have preferred.

Of course now that the Aussie dollar has fallen over 10% in recent weeks the opposite result is evident.

Before you go screaming out and selling hedged international investments to buy un-hedged international investments, spare a moment of reflection.  As Robin Bowerman points out, currency risk is another risk in the marketplace and as with other levels of risk it is very difficult to predict the movement of this risk (i.e. the movement of the currency).  The exchange rate could quite easily swing back around and reach parity with the US dollar, something that has been predicted to occur.

If you have a long term outlook, as Bowerman points out, the impact of currency seems to be negligible.  Actually there is a small cost involved with hedging so some might say, as do we at A Clear Direction, that you are better off leaving international investments un-hedged.  Other reasons for coming to this conclusion are the tax ineffectiveness of hedging and the international investments become more closely correlated to the Australian market and as a result provide less diversification for your overall investment portfolio. 

One last comment though, an area of international investing we do favour a hedged approach is in international property.  If you are expecting significant flows of income back from an investment, like property has provided, it may well be worth considering a hedged position to be more certain about the income flows back into portfolios.

It will be interesting to see where the Aussie dollar ends up.